Precautionary Saving and the Marginal Propensity to Consume out of Permanent Income
The budget constraint requires that, eventually, consumption must adjust fully to any permanent shock to income. Intuition suggests that, knowing this, optimizing agents will fully adjust their spending immediately upon experiencing a permanent shock. However, this paper shows that if consumers are impatient and are subject to transitory as well as permanent shocks, the optimal marginal propensity to consume out of permanent shocks (the MPCP) is strictly less than 1, because buffer stock savers have a target wealth-to-permanent-income ratio; a positive shock to permanent income moves the ratio below its target, temporarily boosting saving.
Thanks to an anonymous referee whose comments substiantially improved the paper. The paper's title is intended as homage to Miles Kimball's paper "Precautionary Saving and the Marginal Propensity to Consume." The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Christopher D. Carroll, 2001. "Mathematica code for Precautionary Saving and the Marginal Propensity to Consume out of Permanent Income," QM&RBC Codes 39, Quantitative Macroeconomics & Real Business Cycles.
Carroll, Christopher D. "Precautionary Saving and the Marginal Propensity to Consume Out of Permanent Income." Journal of Monetary Economics 56, 6 (September 2009): 780-90. citation courtesy of